This week the Federal Reserve’s Open Market Committee — the group of men and women who set US monetary policy — will be holding its sixth meeting of 2013.

Don’t tighten until you can see the whites of inflation’s eyes. Give jobs a chance.

At the meeting’s end, the committee is widely expected to announce the so-called “taper” — a slowing of the pace at which it buys long-term assets.

Memo to the Fed: Please don’t do it. True, the arguments for a taper are neither crazy nor stupid, which makes them unusual for current US policy debate. But if you think about the balance of risks, this is a bad time to be doing anything that looks like a tightening of monetary policy.

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OK, what are we talking about here? In normal times, the Fed tries to guide the economy by buying and selling short-term US debt, which effectively lets it control short-term interest rates.

Since 2008, however, short-term rates have been near zero, which means that they can’t go lower (since people would just hoard cash instead). Yet the economy has remained weak, so the Fed has tried to gain traction through unconventional measures — mainly by buying longer-term bonds, both US government debt and bonds issued by federally sponsored home-lending agencies.

Now the Fed is talking about slowing the pace of these purchases, bringing them to a complete halt by sometime next year. Why?

One answer is the belief that these purchases — especially purchases of government debt — are, in the end, not very effective. There’s a fair bit of evidence in support of that belief, and for the view that the most effective thing the Fed can do is signal that it plans to keep short-term rates, which it really does control, low for a very long time.

Unfortunately, financial markets have clearly decided that the taper signals a general turn away from boosting the economy: expectations of future short-term rates have risen sharply since taper talk began, and so have crucial long-term rates, notably mortgage rates. In effect, by talking about tapering, the Fed has already tightened monetary policy quite a lot.

But is that such a bad thing? That’s where the second argument comes in: the suggestions that there really isn’t that much slack in the US economy, that we aren’t that far from full employment.

After all, the unemployment rate, which peaked at 10 per cent in late 2009, is now down to 7.3 per cent, and there are economists who believe that the US economy might begin to “overheat,” to show signs of accelerating inflation, at an unemployment rate as high as 6.5 per cent. Time for the Fed to take its foot off the gas pedal?

I’d say no, for a couple of reasons.

First, there’s less to that decline in unemployment than meets the eye. Unemployment hasn’t come down because a higher percentage of adults is employed; it’s come down almost entirely because a declining percentage of adults is participating in the labour force, either by working or by actively seeking work.

And at least some of the Americans who dropped out of the labour force after 2007 will come back in as the economy improves, which means that we have more ground to make up than that unemployment number suggests.

How misleading is the unemployment number? That’s a hard one, on which reasonable people disagree. The question the Fed should be asking is, what is the balance of risks?

Suppose, on one side, that the Fed were to hold off on tightening, then learn that the economy was closer to full employment than it thought. What would happen? Well, inflation would rise, although probably only modestly. Would that be such a bad thing?

Right now inflation is running below the Fed’s target of 2 per cent, and many serious economists — including, for example, the chief economist of the International Monetary Fund — have argued for a higher target, say 4 per cent. So the cost of tightening too late doesn’t look very high.

Suppose, on the other side, that the Fed were to tighten early, then learn that it had moved too soon. This could damage an already weak recovery, causing hundreds of billions if not trillions of dollars in economic damage, leaving hundreds of thousands if not millions of additional workers without jobs and inflicting long-term damage as more and more of the unemployed are perceived as unemployable.

The point is that while there is legitimate uncertainty about what the Fed should be doing, the costs of being too harsh vastly exceed the costs of being too lenient. To err is human; to err on the side of growth is wise.

I’d add that one of the prevailing economic policy sins of our time has been allowing hypothetical risks, like the fiscal crisis that never came, to trump concerns over economic damage happening in the here and now. I’d hate to see the Fed fall into that trap.

So my message is, don’t do it. Don’t taper, don’t tighten, until you can see the whites of inflation’s eyes. Give jobs a chance.

The New York Times

16 comments

I have no money, no resources, no hopes. I am the happiest man alive.

Commenter

Vengence

Location

Date and time

September 16, 2013, 4:16PM

Krugman, as usual, is all in favour of destroying peoples' savings and enriching bankers and property-speculators. Like many other smart people, he has no idea how wealth is actually created - not printed into existence.

The real price inflation in the USA - using traditional measures - is around 5% which means that savings are being decimated.

http://www.shadowstats.com/alternate_data/inflation-charts

and the real unemployment is around 23%:

http://www.shadowstats.com/alternate_data/unemployment-charts

These amazingly bad results are a direct result of the Central Bankers trying to help their friends in the banking industry and government. It is theft.

He knows wealth is created .And Banks are Corporations.Read the Act.He is acting precisely in accordance with law,and with the integrity the peoples vision of democracy has allowed.

Commenter

Jane

Location

Date and time

September 16, 2013, 6:58PM

Shadowstats are bogus.http://delong.typepad.com/sdj/2011/12/james-hamilton-on-shadowstats-and-niall-fergusons-claim-that-true-inflation-is-more-than-10-per-year.html

You are making wild statements about Krugman's motives and basing them on dubious evidence.

Commenter

Thatsrightjack

Location

Date and time

September 16, 2013, 9:41PM

Great comment......how REFRESHING to see such a comment even allowed here, betwixt the usual drivel of fools boasting about their "shorts" and how much money they have made today at "The Casino". Well done.......

Commenter

The Seer

Location

Date and time

September 17, 2013, 10:39AM

The Seer,

Thank you. I was a bit surprised too.

Sadly, my reply to Jane and Thatsrightjack was not published.

Commenter

Alfred

Location

Melbourne

Date and time

September 20, 2013, 10:45AM

The money printing is sound policy now. The real problem was what happened prior to 2008. Under deregulation investment banks were allowed to lend to anyone and sell on the risk. These sub-prime assets were rated AAA by dubious methods and were proven to almost worthless later. The US government concluded that it had to guarantee the loans because the banks and their paper were too big to fail. The GFC continues as the US covers these sub-prime assets by effectively printing money. It now has no other choice because to stop would cause a deep recession rather than a justified devaluation of its currency which has occurred.